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CHAPTER 6

Accounting for and Presentation of Property, Plant, and Equipment, and Other Noncurrent Assets
McGraw-Hill/Irwin 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

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What Should You Learn in Chapter 6?

1. How the cost of land, buildings, and equipment is reported on the balance sheet. 2. How the terms capitalize and expense are used with respect to property, plant, and equipment. 3. Alternative methods of calculating depreciation for financial accounting purposes and the relative effect of each on the income statement (depreciation expense) and the balance sheet (accumulated depreciation).

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What Should You Learn in Chapter 6?

4. The accounting treatment of maintenance and repair expenditures. 5. The effect on the financial statements of the disposition of noncurrent assets, either by sale or abandonment. 6. The difference between an operating lease and a capital lease. 7. The similarities in the financial statement effects of buying an asset compared to using a capital lease to acquire the rights to an asset.

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What Should You Learn in Chapter 6?

8. The meaning of various intangible assets, how their values are measured, and how their costs are reflected in the income statement.

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Noncurrent Assets
Land Buildings Equipment

1) Classified as Assets because they are owned by the organization 2) Have the ability to generate Revenue beyond 1 year

Intangible Assets

Natural Resources

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Primary Issues for Noncurrent Assets

Acquisition Accounting for acquisition of the asset.

Use Accounting for depreciation of the asset. Accounting for maintenance and repair costs.

Disposal Accounting for the disposition of the asset.

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LO1

Land
Land is a nondepreciable asset. All costs incurred to get land ready for use are capitalized.

Title insurance premiums Purchase price Delinquent taxes Demolition costs of building on the land

Real estate commissions Title and legal fees

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LO1

Land

Assume that a company pays $250,000 to purchase land and get it ready for use in its business on January 01. The following journal entry would be made to capitalize the $250,000:
GENERAL JOURNAL
Date Account Titles and Explanation Cash Debit 250,000 250,000 Credit

Jan. 1 Land

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LO1

Land

If 5 years later, on January 01 that same piece of land is sold for $300,000, the entry to record the sale would be:

GENERAL JOURNAL
Date Account Titles and Explanation Land Gain on Sale of Land Debit 300,000 250,000 50,000 Credit

Jan. 1 Cash

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LO1

Basket Purchase
The total cost of a combined purchase of land and a building is allocated to each asset on the basis of relative market values and each asset is recorded separately.

On January 1, UpCo purchased land and building for $200,000 cash. The appraised values are building, $162,500, and land, $87,500. How much of the $200,000 purchase price will be charged to the building and land accounts?

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LO1

Basket Purchase
Asset Land Building Total Appraised Value a $ 87,500 162,500 $ 250,000 % of Value b* Purchase Price Apportioned Cost

c b c 35% $ 200,000 = $ 70,000 65% 200,000 = 130,000 100% $ 200,000

* $87,500 $250,000 = 35%

$162,500 $250,000 = 65%

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LO1

Buildings and Equipment

All costs incurred to get an asset ready for use are capitalized. Purchase price Installation costs

Architectural fees

Transportation costs

Cost of permits

Excavation and construction costs

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LO2

Depreciation
Depreciation is the allocation of the cost of an asset to the years in which the benefits of the asset are expected to be received. It is an application of the matching concept.
Balance Sheet Acquisition Cost (Unused) Cost Allocation Expense (Used)

Income Statement

Does not reflect decline in value

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LO2

Depreciation
Depreciation expense is recorded in each fiscal period.
GENERAL JOURNAL

Date

Contra-asset accounts Account Titles and Explanation Debit

used to segregate$$$$ depreciation from Accumulated Depreciation original cost

Credit $$$$

are XXX XX Depreciation Expense

Contra-asset

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LO2

Balance Sheet Presentation

Cash Accounts receivable Building Less: Accumulated depreciation Truck Less: Accumulated depreciation $ 3,925 75

JJ's Lawn Care Service Partial Balance Sheet May 31, 2001 Assets

Depreciation

$ 600,000 55,000 $ 545,000 $ 25,000 Owner's Eq 10,000 15,000 Jill Jones Total

Liabilities Notes pay Accounts Total lia

Net Book Value (NBV)

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LO2

Depreciation
Income Statement

Depreciation Expense

Depreciation for the current year

Accumulated Total depreciation recorded Depreciation as of balance sheet date

Balance Sheet

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LO3

Depreciation Methods

In the early years of an assets life, diminishing balance depreciation methods result in greater depreciation expense and lower net income than straight-line depreciation.
Straight-Line Depreciation
Annual Depreciation Expense ($)

Diminishing Balance Depreciation

Annual Depreciation Expense ($)

Years of Life

Years of Life

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LO3

Depreciation Methods
Straight-Line Methods Straight-line Units of production Diminishing Balance Methods Sum-of-the-years-digits Declining balance

Straight-Line Depreciation
Annual Depreciation Expense ($)

Diminishing Balance Depreciation

Annual Depreciation Expense ($)

Years of Life

Years of Life

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LO3

Straight-Line Method
Formula
Cost - Estimated Salvage Value Estimated Useful Life

Annual Depreciation = Expense

EXAMPLE On December 31, 2007, equipment was purchased for $50,000 cash. The equipment has an estimated useful life of 5 years and an estimated residual value of $5,000. SL

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LO3

Straight-Line Method
Cost - Estimated Salvage Value Estimated Useful Life

Annual Depreciation = Expense

Annual Depreciation = Expense Annual Depreciation = Expense

$50,000 - $5,000 5 years

$9,000
SL

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LO3

Straight-Line Method
Depreciation Accumulated Accumulated Undepreciated Expense Depreciation Depreciation Balance Year (debit) (credit) Balance (NBV) Depreciation stops 2007 $ 50,000 2008 $ 9,000 $ when 9,000 $ 9,000 41,000 2009 9,000 9,000 VALUE 18,000 32,000 NBV=SALVAGE 2010 9,000 9,000 27,000 23,000 2011 9,000 9,000 36,000 14,000 2012 9,000 9,000 45,000 5,000 $ 45,000 $ 45,000

Salvage Value SL

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LO3

Straight-Line Method
$10,000 $9,000 $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 2007 2008 2009 2010 2011 2012 For the year ended December 31

Depreciation Expense

Depreciation Expense is reported on the Income Statement.

Book Value

Book Value is reported on the Balance Sheet.

$60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $50,000 $41,000 $32,000 $23,000 $14,000 $5,000

SL

$0 2007 2008 2009 2010 2011 2012 As of December 31

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LO3

Units-of-Production Method
Depreciation Expense Per Unit Produced
= Cost - Estimated Salvage Value Estimated Total Units to be Made

Step 1:

Step 2:
Depreciation Annual Depreciation = Expense Per Unit Expense Produced Number of Units Produced during the Year

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LO3

Units-of-Production Method
On December 31, 2007, equipment was purchased for $50,000 cash. The equipment is expected to produce 100,000 units during its useful life and has an estimated salvage value of $5,000.

If 22,000 units were produced in 2008, what is the amount of depreciation expense?

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LO3

Units-of-Production Method
Depreciation Expense Per Unit = $50,000 - $5,000 = $.45 per unit 100,000 Produced

Step 1:

Step 2:
Annual Depreciation = $.45 per unit 22,000 = $9,900 Expense

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LO3

Units-of-Production Method
Units 22,000 28,000 32,000 18,000 100,000 Accumulated Undepreciated Depreciation Depreciation Balance Expense Balance (book value) $ 50,000 $ 9,900 $ 9,900 40,100 12,600 22,500 27,500 22,500 27,500 14,400 36,900 13,100 8,100 45,000 5,000 $ 45,000

Year 2007 2008 2009 2010 * 2011 2012

Salvage Value

No depreciation expense is recorded if the equipment is idle.

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LO3

Diminishing-Balance Method
Double the Book Value at Straight-line Beginning of Year Depreciation Rate

Annual Depreciation = Expense

Since we are using 2 times the straight-line rate, this is called the Double-DecliningBalance Method.

1 Life in Years

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LO3

Diminishing-Balance Method
On December 31, equipment was purchased for $50,000 cash. The equipment has an estimated useful life of 5 years and an estimated residual value of $5,000. Calculate the depreciation expense for 2008 and 2009.

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LO3

Diminishing-Balance Method
Double the Straight-line Depreciation Rate 2 20% = 40% Depreciation Expense for 2008 40% $50,000 = $20,000

Depreciation Expense for 2009

40% ($50,000 - $20,000) = $12,000

Net Book Value at Beginning of Year

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LO3

Diminishing-Balance Method
Year 2007 2008 2009 2010 2011 2012 Depreciation Expense (debit) $ 20,000 12,000 7,200 4,320 2,592 46,112 Accumulated Depreciation Balance $ 20,000 32,000 39,200 43,520 46,112 Undepreciated Balance (NBV) $ 50,000 30,000 18,000 10,800 6,480 3,888

Below salvage value

($50,000 $43,520) 40% = $2,592

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LO3

Diminishing-Balance Method
Year 2007 2008 2009 2010 2011 2012 Depreciation Accumulated Undepreciated Expense Depreciation Balance (debit) Balance (NBV) $ 50,000 $ 20,000 $ 20,000 30,000 12,000 32,000 18,000 7,200 39,200 10,800 4,320 43,520 6,480 1,480 45,000 5,000 $ 45,000
$1,480 = 6,480 5,000 salvage value

In the latter years, depreciation is limited to NBV X 40%, but the asset cannot be depreciated below salvage value.

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LO3

Comparing Depreciation Methods

$10,000

Straight-Line Annual Depreciation

$8,000 $6,000 $4,000 $2,000 $0 1 2 3 4 5

$16,000 $14,000 $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 1

Units-of-Production

Annual Depreciation

Life in Years
$20,000

Life in Years

Double-DecliningBalance

$15,000 $10,000 $5,000 $0 1 2 3 4 5

Total Depreciation at end of useful life will be the same regardless of Depreciation method

Annual Depreciation

Life in Years

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LO3

Depreciation Methods Used by 670 Companies

22 32 16 8 6 Accelerated method-not specified Units of production Declining-balance Other 586 Sum-of-the-years'digits Straight-line

Source: Accounting Trends and Techniques, 2005, AICPA.

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LO4

Maintenance and Repair Expense

Preventative maintenance expenditures and routine repair costs are clearly expenses of the period in which they are incurred.

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LO5

Disposal of Depreciable Assets

Update depreciation to the date of disposal. Journalize disposal by:

Recording cash received (debit).

Recording a gain (credit) or loss (debit). Removing the asset cost (credit).

Removing accumulated depreciation (debit).

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LO5

Disposal of Depreciable Assets

Determining Gain or Loss

Cash > BV, record a gain (credit). Cash < BV, record a loss (debit). Cash = BV, no gain or loss.

Recording a gain (credit) or loss (debit).

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LO5

Selling Plant Assets

On 9/30/2008, Evans Company sells a machine Date purchased Cost Depreciation Method Salvage Value 1/1/2003 $100,000 Straight Line $20,000

Estimated Useful Life

Selling price

10 years
$60,000

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LO5

Selling Plant Assets

The amount of depreciation recorded on September 30, 2008, to bring depreciation up to date is:
a. b. c. d. $8,000. $6,000. $4,000. $2,000.

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LO5

Selling Plant Assets

The amount of depreciation recorded on September 30, 2008, to bring depreciation up to date is:
a. b. c. d. $8,000. $6,000. Annual Depreciation: $4,000. ($100,000 - $20,000) 10 Yrs. = $8,000 $2,000.
Depreciation to Sept. 30: 9/ $8,000 = $6,000 12

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LO5

Selling Plant Assets

After updating the depreciation, the machines net book value on September 30, 2008, is:
a. b. c. d. $54,000. $46,000. $40,000. $60,000.

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LO5

Selling Plant Assets

After updating the depreciation, the machines book value on September 30, 2008, is:
a. b. c. d. $54,000. $46,000. $40,000. $60,000.

Cost Accumulated Depreciation: (5 yrs. $8,000) + $6,000 = Book Value

$ 100,000 46,000 $ 54,000

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LO5

Selling Plant Assets

The machines sale resulted in:
a. b. c. d. a gain of $6,000. a gain of $4,000. a loss of $6,000. a loss of $4,000.

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LO5

Selling Plant Assets

The machines sale resulted in:
a. b. c. d. a gain of $6,000. a gain of $4,000. a loss of $6,000. a loss of $4,000.

Cost Accum. Depr. Book Value Cash Received Gain

$ 100,000 46,000 54,000 60,000 $ 6,000

Now, you are ready to prepare the journal entry to record the sale of the asset.

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LO5

Selling Plant Assets

Date Description Sept 30 Cash Accumulated Depreciation Gain on Sale Machine Debit Credit 60,000 46,000 6,000 100,000

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LO6

Assets Acquired by Finance Lease

A finance lease results in the lessee (renter) assuming virtually all of the benefits and risks of ownership for the leased asset.

An operating lease is an ordinary lease for the use of an asset that does not involve any attributes of ownership.

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LO6

Assets Acquired by Finance Lease

*Finance Lease Determination according to IAS 17:

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership.

*Finance (Capital) Lease Determination per US GAAP:

If the lease meets one of the following it is a capital lease 1. Transfers ownership to lessee. 2. Includes nominal purchase price. 3. Lease term is 75% of life of asset. 4. Present value of lease payments is 90% of fair value of asset.

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LO7

Buy or Lease an Asset?

Buy or Lease ?

Computer equipment Cost: $217,765 Issue a 10%, 6 year Note Payable Annual payment: $50,000.

Computer Equipment Annual payment: $50,000. Present Value of Lease Payments: $50,000 @ 10%, 6 years = $217,765

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LO8

Intangible Assets
Often provide exclusive rights or privileges.

Noncurrent assets without physical substance.

Intangible Assets
Useful life is often difficult to determine. Usually acquired for operational use.

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LO8

Intangible Assets
Initially record at current cash equivalent cost, including purchase price, legal fees, and filing fees.

Patents Copyrights Leaseholds Leasehold Improvements Franchises and Licenses Trademarks and Trade Names Goodwill

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LO8

International Accounting Standard 38 Intangible Assets An entity shall assess whether the useful life of an intangible asset is finite or indefinite. An intangible asset shall be regarded by the entity as having an indefinite useful life when, based on an analysis of all of the relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. An intangible asset with a finite useful life is amortized and an intangible asset with an indefinite useful life is not.

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LO8

Finite Intangible Assets

Amortization is the term used to refer to the allocation of the cost of an intangible asset over its finite useful life.

The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life. Amortization (or Amortisation) shall begin when the asset is available for use and shall cease at the earlier of the date that the asset is classified as held for sale and the date that the asset is derecognised. Straight-line method is most often used.

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LO8

Indefinite Intangible Assets

An intangible asset shall be regarded by the entity as having an indefinite useful life when there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity.

An intangible asset with an indefinite useful life shall not be amortized but tested for impairment.
Test for impairment by comparing the assets recoverable amount with its carrying amount (book value). Reduce impaired assets to recoverable amounts.

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LO8

Goodwill

Goodwill
Occurs when one company buys another company. Only purchased goodwill is an intangible asset.

The amount by which the purchase price exceeds the fair market value of net assets acquired.

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LO8

Goodwill
Eddy Company paid $1,000,000 to purchase all of James Companys assets and assumed liabilities of $200,000. The acquired assets were appraised at a fair value of $900,000.

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LO8

Goodwill
What amount of goodwill should be recorded on Eddy Companys books? a. b. c. d. $100,000. $200,000. $300,000. $400,000.

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LO8

Goodwill

What amount of goodwill should be recorded on Eddy Companys books? a. b. c. d. $100,000 $200,000 $300,000 $400,000
FMV of Assets Debt Assumed FMV of Net Assets Purchase Price Goodwill $ $ 900,000 200,000

700,000 1,000,000 $ 300,000

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LO8

Goodwill
US GAAP and IFRS have the same nonamortization approach to account for purchased goodwill.

Under the impairment approach, goodwill will only be amortized when the initial recorded value of the asset has deteriorated.

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LO8

Natural Resources

Total cost, including exploration and development, is charged to depletion expense over periods benefited.

Extracted from the natural environment and reported at cost less accumulated depletion.

Examples: oil, coal, gold

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LO8

Natural Resources
Depletion is the term used to refer to the allocation of the cost of a natural resource over its useful life.

The process is similar to units-of-production depreciation.

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LO8

Other Noncurrent Assets

Long-term Investments Notes Receivables (with maturities more than a year after the balance sheet date) Long-term Deferred Income Tax Assets
When these assets become current, they will be reclassified to current assets.

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End of Chapter 6